March 5, 2012

The 2008 Meltdown

“And I plead guilty to falling into that fallacy. I was vaguely aware of the existence of a growing sector of financial institutions that did not look like conventional banks, and were not regulated like conventional banks, but engaged in bank-like activities. Yet I gave no thought to the systemic risks.” ECONOMICS IN THE CRISIS, Paul Krugmam, Winner of Nobel Peace Prize in Economics, February 27, 2012

I am in the mortgage banking business, at present doing commercial real estate loans, with allot of experience with the residential side of the business. In 2004, a long time friend and client asked me to review his new, small residential mortgage business and give him suggestions to improve.

The first thing I did was to underwrite five closed loans. I was aghast at the poor quality and told him the buyers of his loans were going to cut him off because of the poor quality. He laughed and said they were encouraging him to make more of these loans and the securities that were created using these assets were rated AA by Moody’s,

I investigated how the rating agencies could get away with such a rating and was told that they used sophisticated formulas of creating the pools and this minimized the risk by properly structuring the total portfolio or pool. I bought into this story, concluded Moody’s must know what they were doing, and I would let Wall Street worry about it.

Economists may need to plead guilty; however, so should allot of other professionals.

Further, shame on governments for not regulating the industry properly. Free Markets to today’s conservative means the market is free from government interference, including being the referee to the markets making sure they are playing by the correct rules.